Traders ignored another bad sign, this one from the main gauge on small business sentiment, to extend the latest rally to six sessions.  The broad market has recouped 62% of the May-June slide that sent the S&P 500 down 16% from the April 23 19-month high; currently the market is off that mark by 10% -- interesting to see just enough weakness in the final 10 minutes of trading to keep us in bear market territory. 

NFIB goes kerplunk…the market says: Who cares? 

Stocks got a boost from a rally in Europe the night before, investor sentiment bounced after Greece found strong demand via their auction of six-month bills below 5%.  But one shouldn’t read too much into it as European banks provided the demand – and if the ECB wasn’t accepting government bonds (no matter the credit rating) as collateral for their lending facility then demand would have been much weaker. 

Also helping U.S. stocks were good second-quarter earnings reports from Alcoa, Weyerhaeuser and CSX – I think those looking at Q2 results may be relying on false signals.  On a number of occasions, we’ve mentioned that Q2 earnings results would be good (the profit-cycle peak in my view as the inventory dynamic and government stimulus also peaked in the quarter), it’s the third quarter and beyond that’s the concern. 

Alcoa will run into trouble when they report Q3 results as aluminum prices have slid 20% over the past two months.  The company expects something much better for Q3 than I believe is likely, basing it on the continuation of solid global auto production…um, well we’ll see.  Weyerhaeuser, in their quarterly commentary, stated that housing is in recovery.  That statement is so Q2.  With home sales plunging now that the tax credit has expired, I suspect their tune will change next earnings seasons.  CSX also issued a good Q2 report, rail and intermodal deliveries are looking very good relative to last year – CSX’s operating earnings fell 20% a year ago. 

Darn, that’s a really negative take on things, and seems pretty removed from reality on a +1.54% day for stocks.  Sorry about that, I’ll become more positive in time, but it’s likely to be a while.  For me, it’s a combination of the direction of policy and structural challenges – and policy is not helping to resolve those challenges.

Market Activity for July 13, 2010

NFIB Small Business Optimism

The National Federation of Independent Business reported that their gauge of small business sentiment for June fell back below 90, which makes for a pretty horrible report – so after a one month blip above 90, the gauge is back below and that’s never happened in the survey’s 35 year history.  The reading fell to 89.0 in June from 92.2 for May.

Importantly, the readings on outlook six months from now also deteriorated, and that’s bad for job growth – something we need not only to get household balance sheets right again, but finances of states and municipalities.

All of the segments of the report remained low or deteriorated from already low levels.  Plans to hire, higher selling prices, increased capital spending, inventory satisfaction, easing of credit conditions, good to time expand, positive earnings trends – responses to all of these questions remain at recessionary levels.  Even plans to increase inventories, which bounced to a pretty good reading in May, fell back to negative territory in June.

What’s worse, responses to the forward looking indicator --  expect a better economy and expect higher sales – got smashed back to negative readings that only look good relative to the deep levels hit during the worst stages of the credit crisis. 

So for three quarters now earnings and access to credit have improved greatly for the largest businesses.  But things are quite different for the smalls, which can’t go to the capital markets to access funds, are harder hit by legislation that will increase the cost of labor, and are put at a competitive disadvantage by the regulatory burden – larger firms don’t have nearly the problem with a more oppressive regulatory regime because they know it damages their competition more than it hurts them; they can more easily absorb these costs. 

Trade Figures

The U.S. trade deficit rose 4.8% in May to -$42.266 billion – and compared to the previous quarter the figure is on pace to widen, which will drag on GDP to some degree.  The widening can’t be blamed on petroleum imports, which is usually the case, as crude oil imports slid -$9.5 billion. 

Export activity looked really good in May, up 2.4%, as capital goods, computer accessories, telecom equipment and consumer goods were all strong.  But imports were stronger.  Strong import data generally shows that strong consumer demand is present here at home. Today, I don’t feel one can come to this conclusion, as activity has been boosted by artificial means – a Fed at zero and massive government spending.  Further, remember this is May data so there is probably still some business inventory building in the figure. 

Unfortunately (but necessary), there will be a payback period to this pretty hefty string of import data over the past three months since it hasn’t been driven by solid income gains but those artificial means mentioned above.  The trade deficit will narrow again as we head into year-end, and the conventional economist will find glee in this as it occurs – they are so myopic in their thinking they see a narrowing and don’t always see the reasons, for many of them at least.  However, they won’t celebrate it for long, as it will be driven by the next round of consumer weakness, which will become evident in the absence of strong and consistent job growth. 

Last thing, when the economy eventually stabilizes and is set on more solid footing, trade deficits will be a fact of life as most of it is driven by oil imports, and it sure doesn’t look like we’ll be expanding domestic production anytime soon – thanks BP. 

And speaking of BP, if I may digress, their vaunted “tight seal” they’re supposed to have on the gushing well this week looks increasingly like another ruse just to buy time until those relief wells are completed.  

Futures

Intel knocked the cover off the ball last night,  reporting revenue and profit that easily surpassed estimates – it was the best quarter in their 42-year history.  They also upped their gross margins to 67% from 64% for the current quarter – which is much easier to come by after you’ve slashed and burned payroll.  The company said: “[t]he recovery has legs” and “the PC market will rise as much as 16% annually through 2014”  I’m going to remember they said that, the OEMs in Taiwan are talking second-half slowdown.

The time will come for a recovery to have legs and tech equipment in generally will go on an extended period of growth again in time – tech is one of the key places to be over the next decade, along with industrials and energy, in my opinion.  But we’ve got a lot of structural weakness to fight through first.  If executives are truly this ebullient, then why isn’t hiring increasing to a degree that matches this spoken optimism? 

Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900